Part of the problem is that "people didn't understand the risks" involved in investing in these securities, Gundlach said. "Now that the tide's going out, all the wreckage is showing up at the bottom of the sea," he said. "The delinquency rat
e is climbing, and it should climb at a very high rate."
Clearly, however, the easy lending standards that facilitated the current crisis in subprime, combined with huge amounts of capital searching for added yield, has created a troublesome environment. Gundlach suggested that those who stand the greatest chance of being hit hardest by subprime-exposed CDO losses are less experienced investors, the proverbial "two-guys-and-a-Bloomberg," as well as those who were late entrants to the market, and holders of 2006 subprime bond pools (the most troubled group).
Following Gundlach's talk, Scott Berry, Morningstar U.S.'s associate director of mutual fund analysis, said that U.S. domiciled fixed-income mutual funds haven't sustained much damage thus far from subprime exposure, and most bond-fund managers have limited subprime exposure. A few of the exceptions are Fidelity Short-Term Bond which has been modestly impacted by its subprime exposure, and Regions Morgan Keegan Select High Income which has taken a greater hit.
Of course, some enterprising managers have been able to profit from the subprime decline. The team at Dreyfus Premier Core Bond for example, purchased a derivatives position with insurance-policy-like qualities that was tied to subprime home equity asset-backed securities. When the subprime sector began collapsing in early 2007, the value of the position appreciated greatly. By March, the team had exited the position and searched out opportunities in beaten-down issues of stronger subprime lenders where it saw value. Investors should keep a close eye on their portfolios as the subprime crisis unfolds, though panic would be a mistake.
Note: All funds referenced in this article are U.S. domiciled offerings.
